Table of contents

What is Economic Profit?

It is the difference between Revenue of the firm and Economic Costs. Economic Cost of an input is the remuneration received by the input in its best alternative employment. Economic Cost includes the explicit cost of an input (For example, wages of the labor, rent paid, interest paid) as well as the implicit cost (For example, rent of the firm’s factory owned by the firm).

Formula of Economic Profit

Economic Profit = Total Revenue - Economic Costs

Basis

Accounting Profit

Economic Profit

Meaning

Accounting profit is the difference between total revenue received by the firm and accounting cost, or explicit cost, or money cost. Accounting cost includes the costs that are paid. For example: labor wages

Economic profit is the difference between revenue received by the firm and the economic costs, which includes both explicit cost and the implicit cost. For example, labor wages (explicit cost), rent of the building owned by the firm (implicit cost).

Formula

Accounting Profit = Total Revenue - Total Money Costs

Economic Profit = Accounting Profit - Implicit Costs

Financial statements

It is included in financial statements of the company

It is not included in financial statement of the company

Scope

It has a comparatively narrower scope.

Comparatively, it has a wider scope.

Use

It is used for various purposes like calculation of taxes and to indicate the overall financial success of the company.

It is used mainly for theoretical analysis.

Magnitude

Accounting profit is generally larger than economic profit. The firm can have huge amount of accounting profit even at zero economic profit.

Economic profit is generally smaller than accounting profit.

Example of Economic Profit

Let us take an example of a firm ABC Ltd which has the following costs and revenues and whose owner is a software engineer and invests his full time in the business:

Total revenue – 15000

Rent of the building (not owned by the firm): 5000

Wages of labor: 2000

Electric charges: 1000

Depreciation: 500

Cost of entrepreneurial services (salary of the owner had he taken job somewhere else as a software engineer): 2000

Rent of the firm’s factory owned by the firm: 1000

Calculation of Profit

Here, total revenue = P2DQ1O

Total cost = P1CQ1O

Thus, total revenue < total cost

Supernormal loss = P1CDP2

Accounting Profit= Total Revenue - Rent of the building (not owned by the firm) - Wages of Labor - Electric charges - Depreciation

Accounting Profit = 15000 – 5000 – 2000 – 1000 – 500

= 6500

Economic Profit= Rent of the building (not owned by the firm) - Wages of labor - Electric charges - Depreciation - Cost of entrepreneurial services - Rent of the firm’s factory owned by the firm

= Accounting Profit – Implicit Costs

Economic Profit = 15000 – 5000 – 2000 – 1000 – 500 – 2000 – 1000

= 3500

What is Negative Economic Profit? Can Economic Profit be Negative?

Yes, the Economic Profit can be negative. Negative Economic Profit occurs when the Total Economic Cost is greater than the Revenue. It is a situation of losses for the firm.

It is explained below under the heading ‘Super Normal Losses’.

Profit and Loss under Perfect Competition in the Short Run

In the Short Run, a firm under Perfect Competition can make Normal Profit, Super Normal Profit or Super Normal Loss.

What is Normal Profit in Economics?

Normal Profit is a situation of no profit - no loss for the firm. It occurs when